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Using the IS-LM-AD-AS model illustrate the appropriate monetary-fiscal policy mix for an economy experiencing a substantial...

Using the IS-LM-AD-AS model illustrate the appropriate monetary-fiscal policy mix for an economy experiencing a substantial fall in GDP, rising unemployment and a falling price level.

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To reduce the level of GDP, government can reduce its expenditure and raise tax which will shift the IS curve backward to IS1 and Fed can reduce their money supply which will shift their money supply backward to LM1. It will shift the equilibrium from point A to C which will keep the rate of interest intact and reduce the output level from Y* to Y2.

When money supply as well as government expenditure have fallen, aggregate demand will fall while aggregate supply will remain constant. It will reduce the price level from P to P1.

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